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Planning for the Future

Your client earns too much to have a Roth IRA? Not for long!

By Gregory B. Gagne, ChFC

On May 6, 2006, the Tax Increase Prevention and Reconciliation Act became law in the United States. This law has created an excellent planning opportunity for you and your client to prepare to enjoy the tax-free benefits of a Roth IRA.

The problem
The current rules for Roth eligibility prevent contribution to a Roth if your client earns too much income. (Currently the phase-outs occur at $160,000 of modified adjusted gross income if filed as a married couple, and $110,000 of MAGI for a single filer). Additionally, your client is unable to convert his existing IRAs to a Roth IRA if his income exceeds the $100,000 MAGI threshold. As a result, many of your clients may be unable to establish a Roth and convert to a Roth IRA at this time.

The great news is that with the enactment of this law in 2010, the $100,000 MAGI limit will be eliminated, thereby allowing anyone who wishes to convert to a Roth IRA to do so.

The planning opportunity
If you have a client who is prohibited from contributing to a Roth IRA because of his earnings, consider having this client contribute to a nondeductible IRA for 2007, 2008 and 2009. In 2010, your client can then convert the nondeductible IRA to a Roth IRA when the $100,000 MAGI threshold is removed. The client will pay taxes on the amount of deferred gain in the IRA as ordinary income when converted. There is a very important caveat to understand, however. If the client has other IRA assets, those assets will be aggregated for the purpose of calculating the taxable basis upon conversion. This technique will work best for clients who are actively contributing to an employer-sponsored plan and have no IRA assets at this time. There are techniques to mitigate this problem, but they are beyond the scope of this article.

Case in point
For example, John Smith works for the XYZ Company and contributes to the company’s 401(k) plan each year. He has done this for many years, and the plan is valued at $300,000. Smith is married and his earnings are more than $180,000 per year. He has no IRAs at this time. His income prohibits him from contributing to a Roth IRA. He has heard much about the Roth plan and is disappointed that he cannot contribute to it.

The technique
Smith, although unable to contribute to a Roth IRA, is not prevented from opening and funding a nondeductible IRA for him and his wife. Since both of them are over 50 years old this year, they establish two nondeductible IRAs and fund each with the $4,000 base contribution and also the $1,000 “catch-up” contribution available for those over age 50. Mr. Smith does this for 2007, 2008 and 2009.

The Tax Increase Prevention and Reconciliation Act of 2006 removes the $100,000 MAGI limit in 2010. In 2010, Smith converts his and his wife’s nondeductible IRAs to two Roth IRAs. The tax is due only on the gain in the account during the past few years. Remember that he has no other IRAs; therefore, only the nondeductible IRA is used in the conversion calculation. Although he was unable to establish a Roth up front as a result of the change in this law, he will still have the opportunity to enjoy a Roth with some preplanning. The extra benefit is that the taxes are not due in 2010 when he converts. The taxes can be paid over the next two tax years in 2011 and 2012.

Take some time to educate your high-income clients about the potential of this valuable planning technique. Guide them in creating tax-free wealth, and you will build clients for life.

Gregory B. Gagne, ChFC, is the owner of Affinity Investment Group, LLC, past president of NAIFA New Hampshire and a member of MDRT. For additional information, contact him at



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